Fiscal transfers based on inputs or outcomes? Lessons from the Twelfth and Thirteenth Finance Commission in India

There is limited empirical evidence about the efficacy of fiscal transfers for a specific purpose, including for health which represents an important source of funds for the delivery of public services especially in large populous countries such as India.

To examine two distinct methodologies for allocating specific-purpose centre-to-state transfers, one using an input-based formula focused on equity and the other using an outcome-based formula focused on performance.

We examine the Twelfth Finance Commission (12FC)'s use of Equalization Grants for Health (EGH) as an input-based formula and the Thirteenth Finance Commission (13FC)'s use of Incentive Grants for Health (IGH) as an outcome-based formula. We simulate and replicate the allocation of these two transfer methodologies and examine the consequences of these fiscal transfer mechanisms.

The EGH placed conditions for releasing funds, but states varied in their ability to meet those conditions, and hence their allocations varied, eg, Madhya Pradesh received 100% and Odisha 67% of its expected allocation. Due to the design of the IGH formula, IGH allocations were unequally distributed and highly concentrated in 4 states (Manipur, Sikkim, Tamil Nadu, Nagaland), which received over half the national IGH allocation.

The EGH had limited impact in achieving equalization, whereas the IGH rewards were concentrated in states which were already doing better. Greater transparency and accountability of centre-to-state allocations and specifically their methodologies are needed to ensure that allocation objectives are aligned to performance.